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23 Mar. 2010 | Comments (0)

It looks like more boards and management are taking seriously the effect ethics has on corporate governance and the bottom line. I base this observation on recent conversations with principals of a nascent firm that measures governance and systemic risk in the financial sector and the head of the organization devoted to corporate compliance and ethics. And then there’s the statistics. During the economic downturn, the membership of the Society of Corporate Compliance and Ethics (SCCE) rose about 20 percent in 2009. A December 2009 SCCE survey of  412 health care and non-health care compliance and ethical professionals (The Economy, Compliance, and Ethics) found that their compliance and ethics budgets increased 26 percent last year compared to an expected increase of only 15 percent. Additionally, the same survey found that 90 percent believed the current economy either somewhat or greatly increased the risk of compliance and ethics failures. “I think we have been pushing ethics for something like 50 years,” Roy Snell, SCCE CEO, said. “The tide has been turning now as more companies are realizing compliance programs are needed in addition to ethics programs.” He defined ethics as an “outcome” and compliance programs as a process to get to that outcome. It seems that ethics has been a vague ideal that every company strives for, but no one can really measure. Following the accounting scandals of the early 2000s and the financial crisis of 2008-2009, the notion of measuring the ethical behavior and culture of a company has become vital. “The big things that have been missing are enforcement and reporting to the board,” Snell said. “Today, we are starting to have decisive action. In the past, we just had arms flailing.” As for actually measuring the ethics of a company, Snell told me that’s not the hard part because all you have to do is ask employees if they believe management to be ethical. “But, it doesn’t do any good, because how do you get people to be ethical?” he said. “How do you fix it?” It’s a lot more than just creating a code of conduct, which is what regulations and market listing standards require. Snell has a process that he believes works. It requires companies to do the following when it comes to enforcing the code of conduct:
  • Audit
  • Monitor
  • Investigate
  • Discipline
  • Report to the board
Ethics Metrics LLC, a new Charlottesville, Va.-based firm operated by CEO Beckwith B. Miller (former banker with Barclays Bank) and Chair Douglas Q. Holmes (a former bank with Lazard Freres and The First Boston Corp.) believes so much in the importance of ethics it banks it business model on it.  The company has created a patent pending process that measures and rates the impact of material governance risks, including systemic risk, on the earnings, equity values, and investment values of financial holding companies from 2002 to now and beyond. “What pulled us together was the number of violations of ethics we saw,” Miller said. “We asked, ‘What caused the financial crisis?’ And last year we did an in-depth analysis and found complete corporate governance failures. Everyone failed to identify the breaches. Now systemic risk is embedded in the stock values.” Despite the federal government rescue of the largest financial institutions, Miller and his group found that many of the material weaknesses have not been corrected. Their primary worry is that equity prices in the financial sector continue to be inflated because they don’t reflect the violations of federal safety and soundness regulations that banks must abide. Their basis for the name of the company relates to Section 406, which requires public companies to adopt rules to establish a code of ethics for its senior executives, Miller said. The crux of their ethics metrics rating is an Ethics Framework and Systemic Risk Index. Utilizing a rating system similar to the CAMELS (Capital Assets, Management, Earnings, Liquidity, and Sensitivity to market risk) for banks, Ethics Metrics produces a report that shows whether or not a bank is in compliance. The company also produces a rating (The Director Scorecard) that measures degrees of compliance by boards and their management of risks cited in the report. Ethics Metrics has taken its patent-pending process to the United Nations, where it is a signatory of the UN Principles for Responsible Investment, and the International Corporate Governance Network, which it is a member. It has also sent a 120-page white paper to the SEC as a comment on the proposed shareholder director nomination rule. The Conference Board Governance Center includes a whole chapter on Ethics and Compliance Oversight Practices in its Corporate Governance Handbook: Legal Standards and Board Practices (Third Edition) [PDF free for members]. “Boards should take greater responsibility for overseeing the design and implementation of a comprehensive ethics and compliance program, including appropriate whistleblowing procedures that encourage employees to report any misconduct without fear of reprisal,” a chapter summary reads.
  • About the Author:Gary Larkin

    Gary Larkin

    Gary Larkin is a research associate in the corporate leadership department at The Conference Board in New York. His research focuses on corporate governance, including succession planning, board compo…

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